Magazine article Strategic Finance

Taxes on the Internet?

Magazine article Strategic Finance

Taxes on the Internet?

Article excerpt


TWO YEARS AGO, a train wreck between business online and business on main street loomed large on the horizon, and the tax collector's tollbooth was sitting right at the intersection. Congress sensed the chaos that might result and took action.

In 1998, the Commerce Committee of the U.S. House of Representatives passed the Internet Tax Freedom Act in an attempt to throw sand on the rails and yank back on the brakes. It established a three-year moratorium prohibiting new taxes on Internet commerce. And it formed an Advisory Commission on Electronic Commerce (the ACEC) with the charge of investigating the problems associated with online taxation (local, state, federal, and international). The Commission was given two important rules: Formal proposals to Congress would require a supermajority vote (two-thirds majority, or 13 of 19 members voting), and the report was due at the end of April 2000. The makeup of the Commission leaned in the direction of government. There were eight government representatives, eight representatives from business and public interest groups, and three representatives from the Clinton administration. (See "The ACEC at a Glance" for the roster.)

The tax problems created by the Internet involve three issues:

1. Are taxes online legal?

2. Who will collect online taxes, and how will they do it?

3. What about the rest of the world?

The first problem is the thorniest, centering around the legal principle of nexus. The Supreme Court, mainly in the Quill decision of 1992, requires a "substantial nexus" standard, meaning a business must have a physical presence in a state for that state to levy taxes on it. With Internet businesses, home is where the server is. And servers can be small enough to be carried by hand to any taxing or nontaxing jurisdiction. What this does to sales tax is to make places like the Bahamas very enticing. And this portability further complicates the collection of use taxes--taxes that are only easy to collect from businesses registered in the state that's collecting.

Problems two and three have generated all kinds of concern. States, counties, and cities are worried that the revenue stream from sales and use taxes could be substantially decreased by the Internet. Companies worry that governors might assume they can excessively tax those outside their states with no fear of ballot-box retribution. Citizens worry about privacy issues with their personal information being shared by many (unknown) taxing authorities. Brick-and-mortar businesses worry about competition created by tax-free discount selling during the moratorium on taxes and later if Congress decides on no new taxes. And then there's the European Union and the rest of the world. Will tariffs and/or value-added taxes (VATs) on goods and services online change? And what effect will these changes have on present economic balances? The potential for change, maybe even disaster, is all over the landscape, and the locomotives are in motion.

The ACEC met its deadline and, on April 21, 2000, published its Report to Congress (the proposals are summarized in sidebars on pp. 72 and 74). Here's a glance back at the meetings that produced the final results.

NEW YORK, SEPTEMBER 1999 The discussions in the second meeting of the ACEC tended toward basic issues, such as can states legally tax Internet concerns that have no physical presence in their states? Would local and state taxes require that Quill v. North Dakota be overturned?

Ron Kirk, mayor of Dallas, also pointed out that, "The whole industry (Internet) is based on intellectual power, and education is expensive." Because the states are responsible for funding education, anything that reduces their ability to collect sales taxes undermines their ability to pay for schools, and these revenues would have to be made up by increasing property and other taxes. …

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